This article was recently published in Monewyeb’s monthly investment magazine The Investor. The latest issue is now also available for download in both interactive Joomag and more traditional PDF format.
The KAP Industrial of 2015 is a very different business to the one that entered into a deal with Steinhoff back in 2012. That transaction saw KAP take over Steinhoff’s industrial assets – PG Bison, Unitrans and its raw materials subsidiaries – in exchange for KAP shares.
In the process Steinhoff become KAP’s controlling shareholder, but it also turned the latter into a far more substantial company with a leading portfolio of local industrial assets. Management was also quick to understand that it shouldn’t just sit on these acquisitions, but focus the company into a business with a clear strategy, directed at expansion opportunities into the rest of Africa.
“Post the Steinhoff deal, we spent three and a half years rationalising the business to take out low-performing and non-core operations,” says KAP CEO Gary Chaplin. “So the business we sit with today is fundamentally different to the one we had at the date of the Steinhoff deal.”
KAP now has two primary divisions – its diversified logistics business and a diversified industrial segment. The former includes passenger transport as well as specialised logistics services in the petrochemical, agriculture, mining, infrastructure, foods, and specialised warehousing sectors, while the latter covers operations in timber, chemicals, automotive components and integrated bedding.
These are different businesses, with, arguably, very different prospects. However Chaplin says that they are highly complementary.
“The industrial businesses are cash generative, and the investments come in fairly big chunks, but quite far apart,” he says. “For example upgrading a plant or building a new one is a large capital expense, but they run for 20 or 30 years. Logistics is the opposite in that by its nature you are replacing vehicles every five years, so it’s quite cash hungry but with higher growth prospects.”
The company’s plans to grow its operations into Africa have been primarily through its logistics arm. This has seen it partner with clients that it was already serving in South Africa, and taking that relationship across the border.
“Unitrans’ growth into Africa has been on the back of expansion by existing clients and multinationals,” Chaplin says. “We have never gone out and bought businesses, and because of that it has been quite slow and steady.”
The company has now built a footprint across Southern Africa and into East Africa, and there is potential to leverage this further.
“By the nature of the past structure of our logistics business, we were fairly isolated in terms of specific services in specific countries,” Chaplin explains. “We have now restructured to be able to roll out broader services, but this will remain organic rather than acquisitive.”
The case for integrated bedding
In KAP’s diversified industrial arm, there has been a lot of interest in its acquisition of bedding manufacturer Restonic. This has created an integrated bedding business of high potential.
“Steinhoff years ago had its own bedding manufacturing business, but it sold this off to private equity while maintaining the raw materials businesses,” Chaplin explains. “These were sold to KAP as part of the Steinhoff deal in 2012. We then sat in a position where we either needed to get out of those businesses, or integrate forward to give meaning to them.”
The Restonic acquisition does exactly that, placing KAP at all points along the value chain. Chaplin believes that this represents a compelling business case.
“If we look internationally, the bedding sector is the most resilient in the furniture industry,” he says. “Through the cycle, it is the most consistent and it gives the best retail margins.”
KAP already has five sites where it manufactures foam, and it intends to roll out the manufacturing of mattresses at all of them. However, Chaplin says that they have no intention of taking this a step further and following Steinhoff into the retail space. “We are primarily in manufacturing and will stay in the manufacturing sector.”
While analysts have supported the deal and the rationale behind it, it is not necessarily a big game changer for KAP.
“Restonic is a great fit for the company, but integrated bedding contributes less than 5% to KAP’s overall operating profit,” says Anchor Capital analyst Sarah Shaw. “So it’s a fantastic business, and huge cost savings will come out of the super factory they are putting together, but in the overall picture of KAP’s life this is not significant enough to make a major difference.”
When releasing its most recent financials, KAP made it clear that it remains on the lookout for acquisition opportunities. Chaplin believes that there are a number of potential targets, but they are assessing their options carefully.
“Within each of our divisions there are bolt-on opportunities that we are exposed to almost every day,” he says. “They would fit within those segments in terms of products that we know, processes that we know and markets that we know. Those are attractive because they carry very low execution risk.”
He adds, however, that there are also larger possibilities that are on the company’s radar.
“We are also exposed to opportunities of bigger businesses that are more diverse, and being diversified ourselves they could fit into our strategy,” Chaplin says. “However these have to be very clearly assessed in terms of our strategic filters of being number one or two in their markets, cash generative, and Africa-focused. We are fairly open to opportunities, but we know what we’re good at and will be quite selective in terms of what we do.”
Current appeal to investors
KAP has rewarded investors well since the Steinhoff deal, with the share price having more than doubled since 2012. It is around 60% higher over the last year alone.
However, analysts suggest that it may now be quite fully priced.
“We believe that KAP’s restructuring and streamlining of operations has already been priced into the share,” says Anchor’s Shaw. “It’s a great company with an excellent management team and backed by Steinhoff, but it is trading at a forward price-to-earnings multiple of 17.8 times, and its dividend yield is not looking attractive at under 2.0%
“KAP’s five-year average return-on-equity is about 11.5% per annum, which is unattractive in comparison to the JSE industrial index’s five-year average of 19%. So our view is that it’s just a bit expensive at the moment.”